By Jeffrey Kennedy
The following is an excerpt from Jeffrey Kennedy’s Trader’s
Classroom Collection. Now through August 17, Elliott Wave International is
offering a special
45-page Best Of Trader’s Classroom eBook, free.
I think that, as a general rule, traders fail
95% of the time, regardless of age, race, gender or nationality. The task at
hand could be as simple as learning to ride a bike for the first time or as
complex as mapping the human genome. Ultimate success in any enterprise requires
that we accept failure along the way as a constant companion in our everyday
I didn’t just pull this 95% figure from thin air either. I borrowed it from the
work of the late, great Dr. W. Edward Deming, who is the father of Total Quality
Management, commonly known as TQM. His story is quite interesting, and it
actually has a lot to do with how to trade well.
Dr. Deming graduated with degrees in electrical engineering, mathematics and
mathematical physics. Then, he began working with Walter A. Shewhart at Bell
Telephone Laboratories, where he began applying statistical methods to
industrial production and management. The result of his early work with Shewhart
resulted in a seminal book, Statistical Method from the Viewpoint of Quality
Since American industry spurned many of his ideas, Deming went to Japan shortly
after World War II to help with early planning for the 1951 Japanese Census.
Impressed by Deming’s expertise and his involvement in Japanese society, the
Japanese Union of Scientists and Engineers invited him to play a key role in
Japan’s reconstruction efforts. Deming’s work is largely responsible for why so
many high quality consumer products come from Japan even to this day.
In turn, Japanese society holds Dr. W. Edward Deming in the highest regard. The
Prime Minister of Japan recognized him on behalf of Emperor Hirohito in 1960.
Even more telling, Deming’s portrait hangs in the lobby at Toyota headquarters
to this day, and it’s actually larger than the picture of Toyota’s founder.
So why do people fail? According to Deming, it’s not because people don’t try
hard enough or don’t want to succeed. People fail because they use inadequate
systems. In other words, when traders fail, it’s primarily because they follow
faulty trading systems – or that they follow no system at all.
So what is the right system to follow as a trader? To answer this question, I
offer you what the trader who broke the all-time real-money profit record in the
1984 United States Trading Championship offered me. He told me that a successful
trader needs five essentials:
1. A Method
You must have a method that is objectively definable. This method should be
thought out to the extent that if someone asks how you make decisions to trade,
you can quickly and easily explain. Possibly even more important, if the same
question is asked again in six months, your answer will be the same. This is not
to say that the method cannot be altered or improved; it must, however, be
developed as a totality before implementing it.
2. The Discipline to Follow Your Method
‘Discipline to follow the method’ is so widely understood by true professionals
that among them it almost sounds like a cliché. Nevertheless, it is such an
important cliché that it cannot be ignored. Without discipline, you really have
no method in the first place. And this is precisely why many consistently
successful traders have military experience – the epitome of discipline.
It takes experience to succeed. Now, some people advocate “paper trading” as a
learning tool. Paper trading is useful for testing methodologies, but it has no
real value in learning about trading. In fact, it can be detrimental, because it
imbues the novice with a false sense of security. “Knowing” that he has
successfully paper-traded during the past six months, he believes that the next
six months trading with real money will be no different. In fact, nothing could
be farther from the truth. Why? Because the markets are not merely an
intellectual exercise, they are an emotional one as well. Think about it, just
because you are mechanically inclined and like to drive fast doesn’t mean you
have the necessary skills to win the Daytona 500.
4. The Mental Fortitude to Accept that Losses Are Part of the Game
The biggest obstacle to successful trading is failing to recognize that losses
are part of the game, and, further, that they must be accommodated. The perfect
trading system that allows for only gains does not exist. Expecting, or even
hoping for, perfection is a guarantee of failure. Trading is akin to batting in
baseball. A player hitting .300 is good. A player hitting .400 is great. But
even the great player fails to hit 60% of the time! Remember, you don’t have to
be perfect to win in the markets. Practically speaking, this is why you also
need an objective money management system.
5. The Mental Fortitude to Accept Huge Gains
To win the game, make sure that you understand why you’re in it. The big moves
in markets come only once or twice a year. Those are the ones that will pay you
for all the work, fear, sweat and aggravation of the previous 11 months or even
11 years. Don’t miss them for reasons other than those required by your
objectively defined method. Don’t let yourself unconsciously define your normal
range of profit and loss. If you do, when the big trade finally comes along, you
will lack the self-esteem to take all it promises. By doing so, you abandon both
method and discipline.
So who was the all-time real-money profit record holder who turned in a 444.4%
return in a four-month period in 1984? Answer: Robert Prechter ... and
throughout the contest he stuck to his preferred method of analysis, the Wave
For more trading lessons from Jeffrey
Kennedy, visit Elliott Wave International to download the
Best of Trader’s Classroom eBook. Normally priced at $59, it’s free until
Jeffrey Kennedy is the
Chief Commodity Analyst at Elliott Wave International (EWI). With more than 15
years of experience as a technical analyst, he writes and edits Futures
Junctures, EWI's premier commodity forecasting service.